Efficiency in Deregulated Electricity Markets: Offer Cost Minimization vs. Payment Cost Minimization Auction

This study of the wholesale electricity market compares the efficiency performance of the auction mechanism currently in place in U.S. markets with the performance of a proposed mechanism. The analysis highlights the importance of considering strategic behavior when comparing different institutional systems. We find that in concentrated markets, neither auction mechanism can guarantee an efficient allocation. The advantage of the current mechanism increases with increased price competition if market demand is perfectly inelastic. However, if market demand has some responsiveness to price, the superiority of the current auction with respect to efficiency is not that obvious. We present a case where the proposed auction outperforms the current mechanism on efficiency even if all offers reflect true production costs. We also find that a market designer might face a choice problem with a tradeoff between lower electricity cost and production efficiency. Some implications for social welfare are discussed as well.

Input Aggregation in Models of Data Envelopment Analysis: A Statistical Test with an Application to Indian Manufacturing

A problem frequently encountered in Data Envelopment Analysis (DEA) is that the total number of inputs and outputs included tend to be too many relative to the sample size. One way to counter this problem is to combine several inputs (or outputs) into (meaningful) aggregate variables reducing thereby the dimension of the input (or output) vector. A direct effect of input aggregation is to reduce the number of constraints. This, in its turn, alters the optimal value of the objective function. In this paper, we show how a statistical test proposed by Banker (1993) may be applied to test the validity of a specific way of aggregating several inputs. An empirical application using data from Indian manufacturing for the year 2002-03 is included as an example of the proposed test.